Understanding a Second Mortgage
A second mortgage is a loan that you take against the equity
that you have already built into your home. The proceeds from
the second mortgage can generally be used for whatever purpose
the borrower has in mind. It can be used to pay off a car loan
or credit cards. The proceeds can be used for home improvement
or to take a vacation. The money can even be put in a savings
account for a rainy day fund.
Historically the total amount of debt from the first and second
mortgage combined could not be more than 80% of the total market
value of the home. However, low interest rates and a
competitive marketplace have created a lending environment where
some lenders are approving second mortgages that, when combined
with first mortgage balance, is totaling as high as 125% of the
home value.
However, financial advisors will tell you that carrying that
much debt on your home is never a good idea. I never recommend
borrowing more than 100% of the value of your home and I rarely
recommend a second mortgage with a loan to value of greater than
90%.
Because a second mortgage is a property lien that is placed
behind the first mortgage, this means that in the event of a
default, after the property is sold the first mortgage gets paid
first, including any legal costs and other costs of the sale,
before the second mortgage can be paid. If there is not enough
money from the sale of the home, the second mortgage does not
get paid.
A Higher Interest Rate
When determining the interest rate that a lender is willing to
loan money out for a home mortgage, he looks at the risk level
to him for loaning that money. This is the reason that a high
risk borrower with a poor credit history gets charged a higher
interest rate than a low risk borrower with a strong credit
history.
The same theory holds true with a second mortgage. Because the
lender of the second mortgage is second to be paid off in the
event of a default, and because there is a greater chance that
there might not be enough equity in the home to pay off the
second mortgage in full, second mortgages are usually given at a
higher interest rate than are first mortgages; irregardless of
who the borrower is.
Terms
Although you will have choices for terms when selecting your
second mortgage, in general the terms given for them are shorter
than those of a first mortgage. This is primarily because the
amount of the second mortgage is generally much lower than that
of the first mortgage.
Second mortgage repayment terms can vary considerably, so it is
important that you look around for the one that is best for you.
For the most part they range in length from 5 to 20 years, with
the majority of second mortgage loans being 10 to 15 years. A
select number of lenders will offer a 30 year amortization and
some of them will balloon (set a maturity date) of 15
years. This loan is called a 30 due in 15. Generally, just like
first mortgages, the longer the maturity, the higher the
interest rates. Also, just like first mortgages, the higher the
credit score (FICO) the lower the interest rate.
Just as the length of the second mortgage can vary, so can other
repayment terms. The majority of second mortgages are paid back
in equal monthly payments with a portion of the payment going to
interest and a portion to the principal balance, just like a
first mortgage.
Types of Second Mortgages
The two most common types of second mortgages are the fixed rate
and the HELOC (home equity line of credit). The former is a
standard offering. The HELOC is a little unique and has been
very popular. The loan typically calls for interest only
payments for the first 5 to 10 years and then the line of credit
is frozen at the outstanding balance of the loan. At that
point, the loan payments are recast and a standard principal and
interest payment is established for the remaining 10 to 20
years. The HELOC’s are typically priced with a variable
interest rate that is most commonly indexed to the New York City
prime interest rate.
Pricing on the HELOC’s is like other loan pricing; the lower the
FICO score and the higher the loan to value, the higher the
interest rate.
When considering a second home mortgage, be sure to shop around
and then talk to lenders to ensure that you get the best deal
for you!
